ACC E113 Lecture Notes - Lecture 1: Financial Statement, Supply Chain

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30 Jul 2020

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Document Summary

Shareholders: investors who buy small percentages of large corporations. Creditors: lend money to a company for a specific length of time. They gain by charging interest on the money they lend. Financial activities: the exchanges of money between a company and its lenders and owners. Investing activities: a company"s purchases or sales of stores. 1) purchase products and access to services demanded by customers (negotiate. 2) market the products and series available for sale. 3) sell products and services to customers. 4) collect cash from customers and pay suppliers. Internal decision makers (managers): need information about the company"s business activities to control and improve the operating, investing, and financing activities of the firm. External decision makers (shareholders and creditors): need information about these same business activities to assess whether the company will be able to pay back its debts with interest and pay dividends.

Related Questions

Bob Longs of Longs Jewelers returned to his store in the springof 20x5 angry and depressed. âWe just lost our lease; I donât seehow we can make it now.â It had been seven years since Bob and hiswife, Bonnie, moved their business to Spartanburg, South Carolina.They had struggled, and sometimes excelled. But primarily, throughsheer determination, they just survived in the jewelry business tothis point. The loss of their lease and prime location could be thefinal blow that would destroy their business. Bob needed to decide,and quickly, either to fold the tent or give it one more shot.

York Operations

Longs Jewelers originally started in 1978 as Able Jewelry andMusicâa pawnshop in York, South Carolina, purchased by Bobâsparents from other family members. Bob helped his mom in thebusiness after his graduation from the University of South Carolinawith a major in business in 1989. Wanting to gain more businessexperience, Bob earned his MBA from Regent University in 1993 and,with Bonnie, assumed ownership of the store on July 1, 1993.

Bob and Bonnie met at the University of South Carolina. Shegraduated in three years with a major in foreign politics and aminor in Spanish. After college she was also able to get aPara-legal degree in business and real estate law and bankruptcy.Her legal training made it easy for her to find work with a lawfirm while Bob completed his MBA.

Even though the store was a well-recognized landmark in York, itinitially had trouble earning a reasonable profit. After aboutthree years, Bob saw the 80-20 rule in action. The pawnshopgenerated 80% of the headaches and 20% of the revenue. Bob wantedthe store to be more upscale; he eliminated the electronics andmusical equipment inventory associated with the pawnshop andchanged the name of the store to Longs Jewelers. Over the next fouryears, sales and profits grew.

Bob and Bonnie lived in Spartanburg where Bonnie grew up, about30 miles west of York on I-85. Through their associations andchurch activities, they established a loyal clientele in theirhometown who would travel to York to shop at Longs Jewelers. Manyof these customers often encouraged Bob and Bonnie to open a storein Spartanburg.

In York, however, Bob had the only jewelry store that catered toa middle-class market. Unlike in Spartanburg, where there wereseveral similar jewelry stores already established, he did not haveto worry about competition. The storeâs roots were in York with along history and a devoted following. Even though the drive to worksometimes seemed long, the York site was doing well.

This situation changed about ten years ago. Video poker was thenew craze, and numerous people in the York seemed addicted to it.While illegal in South Carolina, it was legal in North Carolina.Many York citizens frequently drove north a mere 10 miles to thenext state to spend their discretionary income on these games. Bobsaw a change in his customer spending habits as they bought lessjewelry, and some even said they or their spouse used the moneyinstead to gamble and âhit it big.â

At the same time, Yorkâs Main Street was going the way of manysmall towns without a strong economic base. Downtown businesseswere shutting their doors as shoppers drove to new malls orsuperstores like Wal-Mart. The only stores that seemed to beopening on Main Street were loan companies, which offered highinterest rate loans to consumers and businesses. Within two years,this combination of events took Bobâs operation from beingprofitable to barely surviving.

Relocating to Spartanburg

Bob and Bonnie had to decide if it was worthwhile to continuetheir jewelry business. They had two young children and roots inSpartanburg. With Bobâs MBA and business experience, thepossibility of a job at a company in Spartanburg was attractive.Bonnie could stay home and raise the kids, and they would be freeof the pressure of ownership and the worry over cash flow.

It was evident that Longs Jewelers in York would not survive.Persuaded by friends and motivated by his entrepreneurial spirit,Bob developed a business plan and sought financial assistance tomove his operation to Spartanburg. To his surprise, local bankswere not as supportive as Bob thought they would be. LongsJewelersâ current financial condition did not help to qualify for aloan; it seemed too risky. The financial institutions deniedfunding.

Bob liked the idea of being his own boss, enjoyed the jewelrybusiness, and felt he had some expertise in the area. So he keptlooking for financial assistance. Eventually, he returned to hisold bank in York. Even though he was leaving town, based on therelationship he had established with the bank and with theirassistance, he qualified for a Small Business Administration loanof $60,000. Bob and Bonnie sold their house in Spartanburg and usedthe equity to add another $20,000 to start over in Spartanburg.Upon the sale of their house in Spartanburg, Bob and Bonnie andtheir two children, Hannah and Jonathan, moved from a3,200-square-foot home into a 1,200-square-foot apartment.

Spartanburg Operations

Bob secured a lease for almost 3,000 square feet in a primelocation in west Spartanburg on a busy main street across from alarge shopping center. This section of Spartanburg was experiencingsustained consumer consumption since it had easy access to I-85,and new upper-income home developments were opening on a regularbasis. The rent for the store was $3,000 per month. The stripshopping center included some other fine stores, including anupscale womenâs fashion store and a quality shoe store.

Unexpectedly, Bob learned that the landlord charged him anadditional $40,000 to âup fitâ the store before the first sale waseven made. In some of the other lease contracts they considered,âup fittingâ was already provided, and he wrongly assumed thoselease stipulations were included in this current lease. Bob learnedthe importance of âbuyer beware.â He regretted not gettingprofessional guidance before signing the lease, but he was tryingto save money and time. On top of that, Bob later learned that hisshare of the property tax for the facility was also charged to himat the end of the year as an additional expense versus being partof the monthly rent. Already cash poor, Bob used his remaining$40,000 in funds to acquire inventory.

With limited working capital, a discretionary income typeproduct with low turnover, and a seasonal business, Bob continuallyhad cash flow problems. Jewelry was expensive, and the store neededsignificant inventory to display in showcases in order to attractcustomers. He bought lots of silver, which was relativelyinexpensive, to supplement gold and diamonds.

Bob maintained a credit purchasing relationship with many of hissuppliers, but when sales did not achieve anticipated levels, Bobquickly found himself past due on many accounts. It was not longbefore some of these suppliers wanted cash up front for purchases.Conditions seemed to go from bad to worse as debt mounted. In thefirst year, the business lost over $108,000.

Bonnie and Bob both needed to work in the store because at leasttwo people had to be around to prevent theft. With theirresponsibilities as parents, family activities, commitments atchurch, working six days a week at the store was demanding andthere was little down time. They even had to give up attending orwatching the games of their beloved University of South Carolinafootball teamâan activity that in the past often gave themmuch-needed relaxation from the stress of running your ownbusiness.

Fortunately, the clientele from Spartanburg remained loyal andfrequented the store even more now that the business was moreconveniently located in Spartanburg. Store hours were 10:00 a.m. to5:30 p.m., Monday through Saturday. Bob believed that the customershe was trying to reach, primarily non-working women who enjoyedshopping and socializing would shop during the day. These womengenerally entertained, wanted quality family time, and had otherobligations in the evening. Also, this was more of a destinationlocation as opposed to a mall location where there would be morewalk by traffic in the evening.

Bob and Bonnie practiced a high moral and ethical standard andunderstood the importance of trust and honesty. They were fair invaluing stones for both buying and selling purposes, which wasoften a concern by less knowledgeable customers. They were alsofriendly and got to know their customers on a first-name basis.Customer service was highly regarded in all of their businessdealings. As it turned out, many customers bought jewelryexclusively from Longs Jewelers. With over 15 years of experience,plus his educational training, Bob felt he knew the jewelrybusiness and how to make it successful.

Additionally, Bonnie, who was completely self-taught in thejewelry business, had a knack for picking the right products. Shehad always had an interest in colors and texture and was good atdetermining what looked good on fashion conscious women. As ateenager, Bonnie was paid commercial art work for the Governor ofNew Jersey. Since their market was primarily women in a middle- toupper-middle income bracket, it was important for Bonnie torecognize trends and styles when purchasing inventory. She believedin her products and her enthusiasm translated into sales tosatisfied customers. Bonnie also learned to make jewelry. Shebought older jewelry from estate sales and other secondary sourcesat a discounted price and used the materials to make new and moreappealing jewelry items. Customers adored these unique items.

Even though competition from other jewelry stores in theimmediate vicinity was fierce, Longs Jewelers effectively used goodmarketing strategy with ads in popular publications, radio, storespecials, and especially word of mouth primarily catered tomiddle-income earners. They became active in the community andsupported charitable events, which helped to give the businesscredibility. Also their products were more fashion forward andseemed to have a unique appeal to their customers. Their targetcustomers were women who looked for something better than arun-of-the-mill Kmart or Wal-Mart type of product, but not theexorbitantly priced products found at the really upscale jewelrystores. Of course, many of the other individually-owned stores weretrying to capture the same market.

As with many owner-run businesses, Bob and Bonnie focused onlittle, but significant, services. They did engraving, cleaning,and elaborate gift-wrapping at no extra charge. Their bestpromotion was word of mouth and personal friendly service.

Still with all the positive factors that Bob and Bonnie hadgoing for them, maintaining the financial viability of the businesswas still a struggle in a very competitive market. There were anynumber of factors that seemed to impact their potential for successincluding the seasonal nature of sales, high carrying cost ofinventory, high overhead costs, low sales volume, and evensometimes surprisingly low margins on items sold.

At times Bob had trouble making the monthly lease payment on thestore. This last year he was four months behind. Like manybusinesses, the jewelry business was seasonal. The majority ofsales were made during the Christmas season with other peaks inFebruary, May, and June. Months like July and August were extremelyslow. In the past, Bob caught up on the rent payments in Decemberwhen he had a better cash flow.

Over the years, Bob and Bonnie had no choice but to rely oncredit card debt, which had amounted to over $50,000. Once theywere unable to make even the minimum payment, their credit scorestumbledâand they no longer qualified for any personal loans orother credit cards. Nevertheless, they worked hard to repaysuppliers and establish a better relationship with those companiesto hopefully get more favorable terms for future purchases.

Even with their best efforts, the Spartanburg store did not liveup to their expectations. It had been seven years. What did Bob andBonnie have to show for their effort? They had already worked nineyears in York with limited success and now another seven years inSpartanburg. There were good days, but then there were also dayswhen Bob wished just to sell a watch battery. With a $3,000-plusmonthly rent, it was easy for Bob to determine that he needed over$200 in sales (assuming a 100% markup) every day just to pay therent. Sometimes Bob felt he was working for his landlord.

However, Bob and Bonnie both gained much joy selling a qualityproduct, like an engagement ring to a satisfied customer, knowingthey played a role in a special event. Bob and Bonnie enjoyedworking the store together and had complementary skills and astrong marriage even though they were together almost 24-7.

Bob surveyed what he had. His $100,000 of inventory could neatlyfit into a couple of shoeboxes! There was the large safe,showcases, fixtures and some office furniture. Of course, therealso was the $250,000 debt. He felt fortunate that some of the debtwas still interest-free and that his average cost of debt wasaround 11%. He had worked very hard to reduce the level of debtover the past few years. While the total company debt haddecreased, his interest expenses increased as his credit ratingwent down and his perceived riskiness by creditors went up.

If he left the store he asked himself: how was he going to makegood on this debt? Because of their high ethical values andintegrity, Bob and Bonnie felt badly that they had created such abad debt situation, and they felt morally obligated to make good onall of the outstanding debt. Suppliers and others had placed faithin them and given the store favorable credit terms and assumed theywould fulfill these obligations.

Future Operations

If Bob wanted to begin again, could he, especially now that hislease was terminated by his landlord? Seven years ago, he had ahouse with some equity that he sold to raise capital for thebusiness. Now, he did not even have that. It was doubtful that hecould arrange for debt financing, given his history. If he broughtin a partner, that partner would probably want 51% ownership ormore of the business, and he would lose control. Furthermore, couldhe even find a suitable location for his store close to where hehad become established?

He was aware of another location that had recently becomeavailable. It was just three blocks away, but it was only 1,250square feet, 40% of the size of his current store. Bob surmisedthat the monthly lease rate would be about half of his currentrate. What kind of other lease terms would he face with a newlandlord? Bob did not want to be surprised again with hiddencharges in another lease agreement. Also, could he afford the costof a move, especially transporting the large and very heavysafe?

There was also the issue of employees. Because of the need toalways have at least two employees on site, Bob had often hiredextra help at various times during the year. Currently, twoadditional employees had come to depend on Bob and the job fortheir source of income. They too, would have to seek otheremployment. And there were his loyal customers. Many had stuck withhim since his early days back in York. He had spent yearsdeveloping this relationship and market. Did he want to give upthis valuable but intangible resource?

If he folded the business, what would he do? For 20 years he hadbeen in the jewelry business. Working for another company injewelry, like a competitor, seemed like such a step down. He wantedto stay in Spartanburg, and he had plenty of connections. But afterbeing an entrepreneur, could he work for someone else? What wouldBonnie do? Their children were now 12 and 16. How would they reactto this situation? They had already been through a lot.

Bob pulled out his last three years of financial data to try todetermine if they even had resources or the financial viabilityavailable to make the store viable at a new location. From Bobâsunderstanding of the jewelry business, successful operations have agross margin of around 50 percent and a profit margin of at leastfive to ten percent.

Maybe it was time to consider another direction. He had an MBAand years of retail experience, surely he could find a job in theSpartanburg area in the $50,000 to $60,000 range. Plus Bonnie, withher talents and skills in the jewelry business, could easily find apart-time or maybe full time job and earn up to $30,000. Also, withsome catching up on the latest laws in the legal field, she couldprobably get a much higher paying job as a Para-legal with a lawfirm in the area. The thought of using her legal bankruptcytraining on their own store was not amusing. But was it or shouldit be just about the money? They really enjoyed the jewelrybusiness and the relationships established with their clientele.Their faith had remained strong, but this was going to be a test,or was it an opportunity?

Required (Please show your work):

1. What risk factors should Bob bemost concerned about regarding his decision?

2. Identify possible ethical orvalues-based issues that could impact any decision.

3. What should Bob and Bonniedo?

purplehorse332

QUESTION 1 The knowledge of financial accounting can assist people with decisions such as whether to extend credit to a business. True False 0.2 points Saved QUESTION 2 Employees of a company would not have a reason to use the information provided by financial accounting. True False 0.2 points Saved

QUESTION 3 Financial accounting should be used for assessing the financial health of large organizations only. True False 0.2 points Saved

QUESTION 4 Financial accounting can be helpful for a job candidate who is assessing the financial future of a potential employer. True False 0.2 points Saved QUESTION 5 Lenders might use the information produced by financial accounting when making loan decisions. True False 0.2 points Saved

QUESTION 6 Credit analysts prefer not to use information provided by financial accounting, as it is not accurate. True False 0.2 points Saved

QUESTION 7 Financial accounting is helpful to investment advisors. True False 0.2 points Saved

QUESTION 8 Financial accounting is more useful than managerial accounting. True False 0.2 points Saved

QUESTION 9 The decision to buy or rent equipment is an example of a decision aided by managerial accounting. True False 0.2 points Saved

QUESTION 10 Which of the following statements is true of financial accounting? A. It is used by external parties to make investment decisions. B. It is used to make lease or purchase decisions. C. Managerial accounting is another name for financial accounting, D. It is primarily used to make internal decisions of a business. E. The effectiveness of advertising can be judged using financial accounting. 0.2 points Saved QUESTION 11 The charge for using money over time, often associated with long-term loans, is known as: A. interest. B. principal. C. distribution charge. D. cash dividend. E. preferred dividend. 0.2 points Saved QUESTION 12 Which of the following is a common feature of financial and managerial accounting? A. Both have same objectives B. Both are prepared according to U.S. GAAP C. Both are reported at year end in the annual report D. Both are analyzed by external users while making investment decisions E. Both are used by the management in making decisions 0.2 points Saved

QUESTION 13 Dividends are required to be paid to stockholders on an annual basis. True False 0.2 points Saved

QUESTION 14 An individual who owns one or more shares of stock in a corporation is an owner of that corporation. True False 0.2 points Saved

QUESTION 15 Corporations do not exist as separate legal entities apart from their owners. True False 0.2 points Save Answer

QUESTION 16 It is very difficult to buy or sell ownership shares of a corporation in a stock exchange. True False 0.2 points Saved

QUESTION 17 Stock markets match up investors who wish to buy shares with those who wish to sell them. True False 0.2 points Saved

QUESTION 18 Legal process by which owners of an organization apply to a state government to have it identified as an entity legally separate from its owners is called: A. stocking. B. filling. C. attributing. D. registration. E. incorporation. 0.2 points Saved

QUESTION 19 An advantage of ownership in a sole proprietorship over ownership in a corporation is: A. tax benefits. B. having a board of directors. C. the ability to raise capital through issuance of stock. D. separation of owner and business as legal entities. E. limited liability for debts. 0.2 points Saved

QUESTION 20 Who hires the management of a corporation? A. Stockholders B. Board of directors C. Creditors D. Government E. SEC 0.2 points Saved QUESTION 21 Inventory refers to the: A. excess amount paid for an asset over its fair value. B. intangible assets of a business. C. merchandise bought or manufactured for the purpose of selling. D. amount of net income reinvested by company for future operations. E. revenue generated from investment. 0.2 points Saved QUESTION 22 Investors use financial information to predict whether a: A. company will recruit more employees. B. company's stock price will increase C. company has invested in buildings. D. company will pay salaries. E. company's bond price will increase. 0.2 points Saved

QUESTION 23 Financial accounting can be compared to a portrait. True False 0.2 points Saved

QUESTION 24 Financial statements provide the form and structure for the conveyance of financial information that will create a likeness of the reporting organization. True False 0.2 points Saved

QUESTION 25 The information reported in financial statements must be exact for an investor to make any decision. True False 0.2 points Saved

beigeant306

Please answer only "Discussion Question" at theend.

Western States Stationery Case

Western States Stationery was founded in the late 1800s in theSan Francisco area as a one-man operation producing notepaper andcards for sale in the cityâs general stores. By 2004 it had grownto a large paper products corporation with sales more than $2billion.

One division of the company produces specialty paper products,such as writing paper, envelopes, note cards and greeting cards.Another division manufactures and prints business forms. By 2002 itwas one of the top 5 firms in the business forms industry.

For some period, the companyâs sales growth had been relativelyflat and profit margins had been difficult to maintain. Competitionamong suppliers was much more intense than in prior years. In 2002management decided it would venture into business forms inventorymanagement services. This was an area that management thoughtoffered several advantages. These services were thought to beâvalue addedâ allowing the firm to differentiate itself fromothers. Differentiation implied higher margins and the potential tofurther bind customers to Western, reducing the threat they mightswitch to an alternative supplier. Finally, the concept wasrelatively new, with little competition from large firms, therebyoffering high sales growth potential. Western embarked on acampaign to enroll its corporate clients in a program it calledTotal Forms Control (TFC).

By 2004, sales from TFC were about $60 million. Western hadestablished TFC as a separate operation within the business formsdivision. The services provided under TFC included warehousing anddistribution of forms (including inventory financing) as well asinventory control and forms usage reporting. TFC used asophisticated computer system network, which enabled them tomonitor a clientâs forms inventory, forms usage and orderingactivity.

As part of its distribution services, TFC also offeredâpick-packâ services where workers opened full cartons to pick theexact number of forms requested by the clients. TFCâs operatingphilosophy was that a well-run warehousing and distribution networkwas vital to any forms management program ---âwe know what you needâ¦ the right product at the right place at theright time.â

For a small number of clients TFC also offered "desk topdelivery," where TFC personnel would distribute the forms toindividual offices within the customerâs company (otherwise formswere usually delivered only to a receiving dock area). As acomprehensive forms management provider, Western's product linealso had to be comprehensive. Their product line includedeverything from stock computer printout paper and fax paper tocustom designed forms tailored by Western's design consultants tomeet the exact business needs of the client.

TFC also had the ability to custom design its forms managementservices to meet the needs of each of its clients. TFC clientsranged from small businesses, which desired only basic inventorycontrol, to those who had comprehensive forms managementprograms.

CURRENT COST ACCOUNTING SYSTEM

Western operated its forms manufacturing and TFC activities asseparate profit centers. Western manufactured business forms in 13locations. The transfer of product from manufacturing operations toTFC was at arm's length with the transfer price set at fair marketvalue. Although the company encouraged internal sourcing forcustomer orders, TFC salespeople had the option of outsourcingproduct.

Clients who participated in the forms management program kept aninventory of forms at one of Western's 10 distribution centers. Theforms were distributed to the client as they were needed. Theclient was charged a service fee to cover the cost of warehousingand distribution based on a percentage of the cost of sales of theproduct for that month, regardless of the specific level of serviceprovided to that client. The standard charges were as follows:

â¢ Warehousing/Distribution, 20.5% ofproduct cost

â¢ Inventory financing, 4.7% of productcost

â¢ Trucking to the customer, 7% ofproduct cost

If a TFC client made use of any of the distribution services,they were typically charged a price for the forms which was highenough to allow for an additional 20.5% of product cost to coverwarehousing and distribution expenses (everything from storage andrequisition handling up to and including desk top delivery), plus4.7% to cover the cost of capital tied up in inventory, and 7% tocover trucking costs. These percentages were determined based onactual 2002 financial data so that on an aggregate basis, in total,all expenses were covered (see Exhibit 1). Sales prices weregenerally determined by applying a 20% mark-up on the combined costof the product (business forms) and the 32.2% charge for TFCservices. To some degree, prices charged on customer accounts couldvary from the standard formula, based on what the sales departmentthought customers would pay.

UNDERSTANDING CUSTOMER PROFITABILITY

With TFC profitability suffering in October 2002, GeneralManager John Malone began to question the appropriateness of thedistribution charges: "The Business Forms Division used to earn a20% Return on Investment (ROI). But returns have been dropping forseveral years. TFC is projected to earn an ROI of only 6% for 2004.Something tells me that we are not managing this business verywell! It seems to me that the charges for services needs closerscrutiny."

John looked through his records and found two accounts ofsimilar size, accounts A and B, which were handled by differentsalespeople. Accounts A and B had essentially the same annual

sales of about $79,000 with the cost of the product being$50,000. Under the current system, these accounts carried the sameservice charges, but John noticed that these accounts were similaronly in the value of the product being sold; they were verydifferent on the level of service they required from Western.Malone double-checked his records and confirmed that the twoaccounts had indeed generated identical sales revenues (see Exhibit2).

In the past year, customer A had submitted 364 requisitions forproduct with a total of 910 lines (all of them "pick-pack") whilecustomer B had submitted 790 requisitions with a total of 2500lines (all of them "pick-pack"). Customer A kept an average of 350cartons of inventory at the distribution center while customer Bkept 700 on average. Customer B's average monthly inventory balancewas $50,000 ($7,000 of which had been sitting around for a wholeyear) while that of customer A was only $15,000. In addition,customer B had requested desk top delivery 26 times during the pastyear, while customer A did not request desk top delivery at all.John had support staff research the truck operating costsassociated with these customers. Mileage to and from each customerwas estimated and multiplied by an estimated cost per mile. Becauseof the greater activity on customer B's account, a shipment wentout three times a week at an annual trucking cost of $7,500 whileCustomer A required only one shipment a week at an annual truckingcost of $2,250.

With corporate breathing down his neck, John Malone turned toTFC Controller Melissa Dunhill and Director of Operations TimCunningham for help. As a first step, they could provide John withthe following information:

The total expenses for the distribution centers in 2002 wereestimated as follows (in 000's):

Rent	$1,504
Depreciation	$208
Utilities	$200
Salaried payroll	$945
Fringe benefitsâsalaried	$164
Taxes/Insurance	$110
Postage & supplies	$96
Hourly payroll â admin	$476
Fringes â hourly admin	$69
Variable warehouse payroll	$1,599
Warehouse fringes	$336
Total	$5,707

John said, "How am I going to use this information to solve myproblem?" "Well," Tim said, "if we can figure out, without goingoverboard of course, what exactly goes on in the distributioncenters, maybe we can take these financial numbers and assign themto the activities. If we can do that, we'll have a much better ideaof what it costs to serve our various clients." Tim knew that twoprimary activities took place in the distribution centers â thewarehousing of forms and the distribution of those forms inresponse to a customer requisition. He decided to talk to somepeople in the field to get more specific information.

DISTRIBUTION CENTER: ACTIVITY ANALYSIS

John and Tim visited Western's Kansas City, MO distributionfacility. Site manager Wilbur Smith confirmed, "All we do is storethe cartons and process the requisitions. I'll tell you, the amountof warehouse space we need just depends on the number of cartons.If we got into some flexible lease programs and changed aisleconfigurations, we could probably adjust our space requirements ifthe number of cartons we stored was to change. The other thing thatbothers me is that we've got some inventory that's been sittinghere forever.

The team then interviewed warehouse supervisor, Rick Fosmire, "Idon't care if I get a hundred requisitions with one line each orone requisition with a hundred lines on it, my guys still have togo pick a hundred items off the shelves. And those darned"pick-pack" requests. Almost everything is "pick-pack" nowadays. Noone seems to order a whole carton of 500 items anymore. Do you knowhow much more labor it requires to pick through those cartons? Andon top of that, this desk top delivery is a time drain for my guys.It's not like my guys don't have enough to do."

John and Tim returned to Denver with a better idea of whathappens in a distribution center. From what they observed, theybroke the distribution center down into 5 primary value-addedactivities: storage, requisition handling, basic warehouse stockselection, "pick-pack" activity, and desk top delivery.

They turned to Melissa for help assigning costs to activities.Melissa spent considerable time talking to each of the sitemanagers and warehouse supervisors. A consistent picture emerged.The majority (85%) of facility costs related to storage of businessforms. The remainder (15%) was necessary to handle theadministration of requisition processing. Warehouse workers wereinterviewed to determine where they spent their time. The basicprocess of finding and selecting items required half of their time(50%) - this includes finding and selecting either full box ordersor âpick-packâ orders. If the order also required âpick-packâ thisnearly doubled the required time as the workers opened cartons,counted items, etc. Thus, workers estimated that they spent 40% oftheir time dealing with âpick-packâ over and above basic formsselection. Preparing and handling desk top delivery shipments tookup the rest of their time (10%). Based on the above information,Melissa assigned costs to these activities as follows ($'000's).(See Exhibit 3 for calculations):

Storage	$1,625
Requisition Handling	$2,147
Basic Warehouse Stock
Selection	$967
Pick-Pack Activity	$774
Desk Top Delivery	$194
Total	$5,707

Tim then estimated the following for 2004 based upon historicalinformation and current trends:

On average, the 10 distribution centers scattered across thecountry will have combined inventories of approximately 350,000cartons (most cartons were of standard size).

TFC will process about 310,000 requisitions for 2004.

Requisitions will average 2.5 lines of different stationerymaterial requested and pulled.

About 90% of the lines will require an additional "pick-pack"activity (as opposed to shipping an entire carton).

They were still uncomfortable with the way inventory financingand trucking costs were charged out. John checked with the financedepartment and learned that Western obtained financing at the primerate (currently 8%) plus 2%. He thought they could just pass thatalong. "Our new computer system is coming on line soon which willtrack mileage we log to deliver shipments to each customer," saidTim, "so, using a per mile cost we can just charge the client forwhat it actually costs us." They all agreed that this soundedfair.

They were almost finished. "What about desk top delivery?" Timsaid. I think we should charge extra for it, but I don't want thisto get too complicated."

John said, "How much extra time does it take your guys onaverage to prepare a desk top delivery and then run around thecustomerâs company?"

"I'd say about an hour and a half to two hours."

"Alright. At $12 per hour, that's about $24 each time.

"Sounds OK to me. That ties pretty well to the $194,000 overallassignment, since we will process somewhere around 8,500 'desk top'requests this year."

The above information was used to derive activity / cost drivers(See Exhibit 4).

The entire management team, including Doug Kingsley, FinanceDirector of the Business Forms Division, felt that there had to bea better way of charging out distribution services and that thesolution would help TFC become more profitable. They now had a muchbetter understanding of the drivers of costs involved indistribution services. As the four headed off in Doug's SUV for theBroncosâ first home game, they tried to figure out how to use thisinformation to find a workable alternative.

SERVICES BASED PRICING (SBP)

"It would not be easy getting the sales force on board with anactivityâbased pricing program," John said. "Some of them getpretty stuck in their ways and don't like change. Some accountswould see increases because of the additional distribution chargesunder a Services Based Pricing (SBP) scheme. These salespeoplewouldn't be very happy. On the other hand, some salespeople may seetheir margins increase." Overcoming these organizational problemswould be only the tip of the iceberg.

Kingsley, as well as many of the senior managers at corporate,continued to be very concerned with TFC profitability. Whileeveryone thought TFC now had a better understanding of its costdrivers, they were not convinced that overall profitability wouldimprove without significant changes in marketing. They were stillwondering how to use their new activity based costing (ABC)analysis to improve the profitability of TFC. So they decided to doadditional analysis on their customer base.

The accounting department had maintained a database, whichshowed all activity against individual accounts and calculated acontribution from that account. Although TFC maintained 1100separate accounts, a large portion of the business came from veryfew accounts. The top 40 accounts represented 48% of the company'snet sales volume (see Exhibit 5).

As a way of understanding customer profitability, TFC managementreworked the information in the database as if the accounts hadbeen charged service fees based on actual usage, leaving net salesand product cost the same as before. They recalculated contributionbased on these figures. They ranked the accounts according toprofit contribution. Exhibit 6 shows the top 20 accounts for themonth of August and Exhibit 7 shows the bottom 20.

The team looked at all accounts where the revised contributionwas below 20% and determined that if these accounts were managed toa 20% contribution, the profit improvement would be $4.3 millionannually. Of those, the top 40 accounts (ranked by the contributionopportunity if improved to a 20% contribution) represented 70% ofthe $4.3 million opportunity.

Another way of summarizing the range of profitability across the1,100 customers is shown in Exhibit 8. This was a new way oflooking at account management which combined the effects of bothvolume and contribution margin. Since such a large piece of theopportunity rested with these few accounts, management determinedthat it might be possible to significantly improve profitability byconcentrating on individual account management. The team felt theywere on the right track for improving account profitability andwondered what should be the next step. They also wondered whatother issues might be important for improving the overallprofitability of TFC. Management called the ABC based pricingsystem SBP and was seriously considering adopting it for all TFCcustomers.

Case Questions to Consider

How did Total Forms Control (TFC) fit into Westernâs strategy?Was it performing up to expectations?

How did the existing accounting system handle the costs ofservices that TFC provided? Did this suit TFCâs needs?

Using the information in the case calculate ABC based servicescosts per unit of activity for the TFC business. Using these newactivity costs calculate distribution services and gross profit forcustomer A and customer B. What inferences do you draw about theprofitability of these two customers?

What does TFCâs analysis of individual customer accounts(exhibits 5-8) suggest about TFCâs overall customer profitability?What might managers do based on this information?

What are likely to be some of the issues in adopting ServiceBased Pricing (menu) pricing? Do you think that TFC shouldimplement the SBP pricing system?

Do you have any additional comments or recommendationsconcerning the Total Forms Control (TFC) business?

EXHIBIT 1
Calculation of Service Fee Charges
(Current Method)
('000's)
2002 Product Sales at Cost		$24,059
2002 Warehousing/Distribution Expense		$4,932
	...% of Product Cost	20.5%
2002 Average Inventory Balance		$10,873
2002 Average Cost of Capital		10.40%
Total Cost of Inventory Financing		$1,131
	...% Product Cost	4.70%
2002 Total Truck Operating Costs		$1,684
	...% Product Cost	7.00%

EXHIBIT 2
Actual Service Fee Charges
(Current Method)
	Customer A	Customer B
Product Cost	50000	50000
Warehousing/Distribution (20.5%)	10250	10250
Inventory Financing (4.7%)	2350	2350
Trucking (7%)	3500	3500
Total Service Fees	16100	16100
Markâup (20%)	13220	13220
Net Sales	79320	79320

EXHIBIT 3
Breakdown of Expenses by Activity
('000's)
	Total Expenses	Share of Expenses
Storage
Rent	$1,504x 85%	$1,278
Depreciation	$208 x 85%	$177
Utilities	$200 x 85%	$170
Total		$1,625

Requisition Handling
Rent	$1,504 x 15%	$226
Depreciation	$208 x 15%	$31
Utilities	$200 x 15%	$30
Salaries + Fringes	$1,109	$1,109
Taxes/Insurance	$110	$110
Postage & supplies	$96	$96
Hourly Payroll + Fringes	$545	$545
Total		$2,147

Warehouse Activities
Variable Warehouse Pay + Fringes	$1,935	$1,935

Basic Warehouse Stock Selection (50%)		$967
"Pick-Pack" Activity (40%)		$774
Desk Top Delivery (10%)		$194
Total		$1,935

EXHIBIT 4
TFC Activities and Cost Drivers
Activities / Cost Driver		Cost Driver in units
Storage / Cartons in inventory	(cartons)	350,000
Requisition handling / Requisitions	(requisitioning)	310,000
Basic Warehouse Stock Selection / Carton lines	(carton lines)	775,000
"Pick-Pack" / âPick-Packâ lines	(Pick-Pack" lines)	700,000
Desk Top delivery / Desk Top deliveries	(Desk Top deliveries)	8500
Inventory financing / Inventory value		Not available or given elsewhere
Trucking / Mileage		Not available or given elsewhere

EXHIBIT 5
TFC Net Sales, 2003
Annual	No. of	% of TFC
Sales/Account	Accounts	Net Sales
>$300,000	40	48%
>$150,000	53	19%
>$75,000	86	15%
>$30,000	143	11%
>$O	778	7%
Total	1100	100%

EXHIBIT 6
Top 20 TFC Accounts for August, 2004
(Ranked by Contribution $)
Account	Actual Net Sales	Product Cost	ABC Based Service Costs	Revised Contribution

1	76,904	49,620	2,862	24,422
2	130,582	74,396	34,578	21,608
3	72,956	48,216	3,456	21,284
4	64,903	37,981	6,574	20,348
5	45,088	26,098	1,309	17,681
6	104,689	62,340	25,356	16,993
7	52,890	32,083	4,386	16,421
8	38,902	23,087	1,245	14,570
9	87,130	54,923	17,685	14,522
10	67,935	42,012	12,290	13,633
11	58,290	32,074	12,834	13,382
12	84,589	54,023	17,528	13,038
13	36,587	22,657	1,345	12,585
14	47,890	32,'545	3,657	11,688
15	56,294	27,801	16,923	11,570
16	61,056	38,924	11,034	11,098
17	56,902	32,789	13,904	10,209
18	45,893	29,570	6,904	9,419
19	62,954	41,034	13,746	8,174
20	26,699	16,830	2,236	7,633
Total	1,279,133	779,003	209,852	290,278

EXHIBIT 7
Bottom 20 TFC Accounts for August, 2004
(Ranked by Contribution $)
Account	Actual Net Sales	Product Cost	ABC Based Service Costs	Revised Contribution
1081	3,657	2,356	2,325	â1,024
1082	38,467	26,301	13,740	â1,574
1083	5,926	3,840	4,214	â2,128
1084	163	89	2,390	â2,316
1085	3,256	2,006	3,590	â2,340
1086	82,086	61,224	23,756	â2,894
1087	29,320	20,647	11,843	â3,170
1088	467	302	4,086	â3,921
1089	17,935	11,087	10,872	â4,024
1090	17,649	12,903	8,903	â4,157
1091	638	420	5,109	â4,891
1092	16,104	9,102	12,134	â5,132
1093	289	178	5,698	â5,587
1094	23,965	17,345	16,523	â9,903
1095	38,065	23,391	27,623	â12,949
1096	32,898	23,054	22,985	â13,141
1097	129,367	73,128	69,527	â13,288
1098	74,569	50,745	45,698	â21,874
1099	88,345	64,930	53,867	â30,452
1100	113,976	82,987	72,589	â41,600
Total	717,142	486,035	417,472	â186,365

Exhibit 8

Current Operation Profit for 2004

The most profitable 5% of customers (55) contribute 80%

The next most profitable 45% of customers (145) contribute 220%.Profit could be 300% of the current level if we dropped theremaining 50% of customers (550)!

48% of customers (528) reduce profit by 140%.

2% of customers (22) reduce profit by 60%.

DISCUSSION QUESTIONS:

Discuss the following concepts only in the context of thisproblem.

1. Alternative Cost Driver Classification Schemes

2. ABC Implementation Issues

3. ABC and Customer Profitability Analysis

4. Activity Based Management

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ACC E113 Lecture Notes - Lecture 1: Financial Statement, Supply Chain

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